Sebi did the right thing in increasing the shares in tradeable contract

The move to increase the total amount used in deciding how many shares are included in one tradeable contract of stock futures and options from existing Rs 5 lakh to Rs 10 lakh by the capital market regulator, securities and exchange board of India (Sebi), is a step in the right direction. Although domestic brokerages do object to it saying that higher amount of capital attached to a single contract will increase the requirement of margin money and other collateral for participants in derivative market. For a retail investor, they say, one contract will mean, either he pays more money as margin or given additional shares as collateral. Hence it is being argued that it will be difficult for them.

We at this paper are of the view that as market regulator, one of the functions of the Sebi is to continuously assess prevailing risks in the market and take necessary measures to contain those risks. Aside from the risks that every equity market face, India has some that are peculiar to it — the risk of throwing management out of the window in bullish times. Unlike developed country, where exposure to equities and related instruments is generally taken through institutional mechanism with a well established risk management, in India, more individuals take direct exposure to equity instruments. These individuals, due to lack of awareness and other reasons, tend to over trade when indices are making new highs every second week.

Given the bullish sentiment that has been prevailing on the street for quiet some time, especially in the last one year, making money in equity market appears to be the easiest thing in today’s world. This feeling of easy money is being exploited by both large and small brokerages that keep churning trading advice to their retail client and make them trade in derivative instruments.

As Sebi cannot ban retail investors from trading in derivative instruments or ask brokerages to stop disseminating their trading advice to retail investors, it has to take measures to ensure that only those investors who understand the risks associated with derivative instruments and also have the necessary amount of capital take exposure to equity instruments. By increasing the limit of underlying values, it makes an investor think twice before taking exposure through derivative instruments as well as ensure that brokers put in place a risk management system. This will also prevent them from pushing their clients toward derivative instruments just to make some extra brokerage. In fact, market regulator should come with a mechanism where cash margins to be given for derivative contract should increase automatically as market moves above certain levels. These margins can be imposed on stock specific levels as well.

If one looks at trade related disputes between retail investors and brokerages, majority of them relate to non-authorised trading in derivative instruments and not in cash segment. In fact, derivative instruments that are essentially supposed to have been used for hedging and managing risks have been turned into instruments of speculation. This is reflected in the open interest positions of options in rupee terms at some strike price, in many cases, it exceeds $2 billion while intraday trading itself in the option of that strike price cross $1billion.

The argument that due to indirect need for higher margins not many retailers will be participating in future and option segment and, thus, process of price discovery will get distorted is wrong. Sometime back, when the limit was raised from Rs 2 lakh to Rs 5 lakh, similar argument were given. But nothing changed as far as the price discovery is concerned, on parameters like impact cost of trade, clearly there has not been even an iota of difference. Let the regulator force investors to keep their guards up when bulls are roaming freely on the street.